ARM’s Had A Bad Rap
Unlike “Fixed Rate Mortgages”, having an interest rate that remains the same for the entire loan term, rates on Adjustable Rate Mortgages (ARM’s) change periodically. You would think in a rising interest rate environment that locking your interest rate would make the most sense – to avoid higher monthly mortgage payments. Then why are ARM’s making a comeback?
To start, ARM’s have lower interest rates than 30-year fixed rate mortgages (so the monthly payment is lower, allowing borrowers to maximize their cash flow). ARM’s therefore offer more payment flexibility (not only can borrowers use the resulting savings towards personal expenses, but they can elect to make additional principal payments on their mortgage).
Plus, people generally do not stay in the same home for more than about 7 years. If you enter into a “7/1” ARM, this means that the interest rate is fixed for 7 years, and then the rate adjusts thereafter based upon prevailing rates at that time. Sound risky?
In the past, ARM’s were much riskier loans. Depending on the lender, ARM’s may have had:
- prepayment penalties
- more frequent rate adjustment periods
- less or no principal amortization
- high or no ceilings on the amount the rate could increase upon adjustment
All of these onerous terms changed with the onslaught of regulations after the housing crisis. Today, ARM’s “cap” the amount of rate increase at the time of the required adjustment – and the interest rate is prevented from increasing by more than 5% over the life of the loan.